Economic Consequences of Conflict: The Rise of Iraq's Informal Economy

Looney, Robert, Journal of Economic Issues

Iraq's economy has undergone a number of profound changes over the last several decades, many of which have had significant implications for the manner in which the country's informal economy has evolved. The statist, heavy-handed economic policies of the Ba'athist government concentrated much of Iraq's productive capacity in nationalized factors, which degraded under the sanctions regime of the 1990s, when both industrial and agricultural production faltered for lack of inputs.

When coalition officials arrived in Iraq after the war, they planned on turning Iraq into a free market economy--a model for capitalism in the Middle East (Looney 2003). As part of this plan, they expected private companies, both foreign and domestic, to play a leading role in jump-starting the economy. Free market incentives driven by pent-up demand and a massive aid-financed reconstruction program were thought to be sufficient to induce a massive wave of investment and hiring of Iraqi workers (Cha 2004). But violence, crime and uncertainty over the future have undermined investor confidence, preventing market-driven mechanisms from playing their anticipated role. As a result, nominal Gross Domestic Product (GDP) contracted by about 35 percent in 2003. It has recovered little since then, despite the U.S.-led reconstruction efforts.

The only part of the economy to have survived both Saddam Hussein and the post-2003 period of instability and insurgency is the country's informal economy. In fact, there is ample evidence that the country's informal economy has expanded considerably since Saddam's overthrow. In this regard, Iraq's informal economy is following a pattern seen in other parts of the world--the informal economy tends to grow during periods of economic crisis. This phenomenon has occurred on each of the main continents:

* In the 1980s, the Latin American economic crisis produced a significant increase in the size of the informal sector and the scope of its activity (Tokman 1992);

* In the Asian economic crisis of the late 1990s, millions of people who lost formal jobs in the former East Asian Tiger countries tried to find jobs or create work in the informal economy (Lee 1998);

* Structural adjustment in Africa caused the disruption of many long-standing employment patterns and the resulting expansion of informal activities. Once developed, the continent's informal sector has continued to grow unabated and increasingly encompasses massive money laundering and counterfeiting operations, illegal trade in minerals, and the trafficking of humans and narcotics (Fashoyin 1993); and

* Economic transition in the former Soviet Union and in Central and Eastern Europe was associated with an expansion of employment in the informal economy, much of which persists today (Oxford Analytica 2004).

Perhaps because of the inherent difficulties in measuring informal economic activities, compounded by the reluctance of many government agencies to acknowledge its importance, the informal economy has been neglected in policy discussions. (1) A similar development is occurring in Iraq, where despite the obvious importance of the informal economy, it is barely mentioned in the many official economic reports. In fact, few systematic attempts have been made to integrate the analysis and quantification of the informal economy into an overall review of economic developments in Iraq. This lack impairs understanding of the fundamental workings of the economy. At the macro level, limited knowledge of the size of the informal economy impedes monetary policy's ability to control inflation. At the sectoral level, neglecting the informal economy blurs the ability to understand what is happening with commerce, services, and the regional flow of goods and services. While at the micro level, lack of information on the informal economy hinders an effective assessment of which households can or cannot cope on their own during the transition. …

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